Futures are financial instruments whose values are derived from an underlying financial asset such as traditional stocks, bonds, or stock index. Therefore, they can be used to gain some amount of exposure to different financial instruments like stocks, indexes, currencies, and commodities.
Futures are great vehicles for hedging and minimizing risks. if someone is already exposed to or earns via speculating, it’s mainly because of their desire to hedge risks.
When choosing between outright trading stocks and trading futures, think about the following:
Futures use high leverage
You as an investor have to put in a margin, which is a fraction of the total amount, to be invested in futures.
The margin somewhat like a security that you have to keep with the exchange in case the market moves opposite to the position you have taken and you suffer losses. The losses may sometimes exceed the margin amount, in which case you have to fund the account more to put the margin to the maintenance level.
What trading futures basically means for you is that you can expose yourself to a much greater value of stock than you could when buying the original stocks. Therefore, your profits also multiply if the market moves in your direction.
Futures Market is very Liquid
The futures contracts are traded in large numbers every single day and therefore the market is very liquid. The constant presence of buyers and sellers in the futures market ensures that market orders can be placed really quickly.
Additionally, this entails that the prices do not get too volatile, especially for the contracts that are close to maturity. A large position may also be cleared out quite easily without any negative impact on the price.
Commissions and Execution Costs are Low
The commissions on futures trades are very low and they are charged when the position is closed. The total brokerage or commission is usually as low as 0.5 percent of the contract value.
On the other hand, it depends on the level of service provided by the broker.
Speculators can make quick cash
An investor with some mad skills can make quick cash in the futures market because he or she is trading 10 times as much exposure than with normal stocks. Also, prices in the futures markets usually move faster than in the cash or spot markets.
Similarly, there’s the risk of losing money, though you can easily minimize that risk by using stop loss orders.
Futures are great for hedging and diversification
Futures are very important vehicles for hedging or managing different kinds of risks. Companies that are engaged in foreign trade use futures to manage foreign exchange risks, interest risks by locking in an interest rate in anticipation of a drop in rates, and price risk to lock in prices of commodities such as oil, crops, and metals that serve as inputs.
Futures and derivatives aid in growing the efficiency of the underlying market since they lower the unforeseen costs of buying an asset outright.